Avoiding The Traps Of Accelerated Depreciation

Avoiding The Traps Of Accelerated Depreciation

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It's common to break out land and building in a rental property for depreciation purposes, but there are many more components to consider. These additional components may include appliances, parking structures, landscaping, furniture, fixtures, and much more. Most importantly, these additional components can be depreciated much faster than land and building.

The result is accelerated depreciation which means more depreciation can be taken sooner.

I think depreciation is like magic. When done properly, it can take rental real estate with positive cash flow and turn it into a loss for tax purposes.

There are two questions I almost always get when I talk about accelerated depreciation:

#1 Does it always make sense to accelerate depreciation?

#2 Won't I have more gain when I sell my property?

These questions lead into the traps to avoid when it comes to accelerated depreciation.

Trap #1 A Big Deduction Isn't Always a Better Deduction

Sometimes taxpayers get caught up in the excitement of claiming the biggest deduction possible without first looking to determine if it will actually reduce their taxes.

A big deduction doesn't always result in big tax savings. This is why the potential tax benefits must be assessed before moving forward with accelerated depreciation.

If there are no tax benefits, then accelerated depreciation may not be the best strategy right now.

Trap #2 Accelerated Depreciation is not a Short Term Strategy

The decision to accelerate depreciation should be part of a long term tax strategy. While the tax benefits can come immediately, there needs to be a focus on the future to truly maximize the benefits.

Accelerated depreciation does result in more gain when the property is sold.

On top of that, the depreciation taken may be recaptured when the property is sold which means a portion of the gain (the portion attributable to the depreciation) may be taxed at ordinary tax rates.

So how is any of this good news for accelerated depreciation?

Here's how. The worst case scenario with accelerated depreciation is that the tax is deferred to a later year. You take the bigger deductions now, enjoy the tax savings now and then pay tax on it later in the form of more gain.

If you've heard me speak, then you probably know deferral is my least favorite type of tax planning, so you may be wondering why I think accelerated depreciation is so important in a tax strategy.

The reason is that deferral is the worst case outcome, and as far as tax planning goes, while deferral isn't my favorite, it can still help minimize taxes. So even the worst case scenario is still good for tax planning.

But even better, there are other possible outcomes that can reduce or eliminate the future tax impact of accelerated depreciation.

Minimize or eliminate the future tax impact of accelerated depreciation A long term strategy is the solution to minimizing or eliminating the future tax impact of accelerated depreciation. Here are a few examples.

Example #1 Not all depreciation recapture is taxed as ordinary income. Some depreciation recapture has a lower tax rate. This means you take the deduction at a higher rate and report the income at a lower rate - this results in permanent tax savings. The key is making sure you are in the right tax brackets now and in the future.

Example #2 Another example is using like-kind exchanges in your long-term tax strategy. With like-kind exchanges, it is possible to avoid depreciation recapture entirely.

Example #3 If you're long-term strategy is to hold the property and pass it to your heirs, then that can work to avoid depreciation recapture.

Example #4 A plan to regularly buy rental property can provide a steady source of accelerated depreciation and compensate for lower depreciation on properties entering the older stages of their depreciable lives.

While there are many traps with accelerated depreciation, there are also many ways to plan around those traps.

About the Author:
It's common to break out land and building in a rental property for depreciation purposes, but there are many more components to consider.

http://www.provisionwealth.com/wealthUArticleDetail.asp?contentdetailid=363&contenttypeid=10&pID=3



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